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Is Dunkin' Stock a Buy?

By Jon Quast – Sep 10, 2020 at 9:30AM

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The dividend may be telling investors to patiently wait on the sidelines.

At this point, it's safe to say Dunkin' Brands Group (DNKN) has survived the worst of the COVID-19 pandemic. Having weathered the crisis so far, we can now ask if it's a good stock to buy today.

To preview, I think Dunkin' could be a safe dividend stock for opportunistic investors, but I would not bet this stock can beat the market average from where it trades today. Here's why.

The outside of a Dunkin' Donuts location.

Image source: Dunkin' Brands.

Surviving a pandemic

Comparable sales at Dunkin' measure sales at locations open at least 13 months. In April, comp sales fell 32% year over year at U.S. Dunkin' locations. But in June, comp sales were only down 9% -- a steady improvement. Furthermore, comp sales at U.S. Baskin-Robbins locations are already higher than pre-coronavirus levels. In short, this business is coming back.

Recent decisions by Dunkin's management confirm the improving health of the business. When reporting its earnings for the first quarter of 2020, management suspended its dividend to preserve cash. However, the dividend was reinstated with the encouraging trends in the second quarter of 2020 at the end of July. 

There's more. In the July 30 report, Dunkin' announced it expected a whopping 800 locations to close permanently, which doesn't look bullish on the surface. But these were underperforming locations (many weren't even stand-alone) and represent a mere 2% of total sales. These closures are being partly offset by opening new locations in new markets like California and Texas. And franchisees plan to hire 25,000 new workers as we move further beyond the worst of the pandemic. 

These points all lead me to believe Dunkin' is back. 

A steaming cup of coffee sits on a table.

Image source: Getty Images.

How the market values this low-growth business

Because of how it's structured, Dunkin' doesn't offer investors much top-line growth. It makes money by collecting franchise fees, royalties, license revenue, and (in some cases) rental payments from the property it owns. But I wouldn't call these growth drivers.

For example, consider Dunkin' has a consumer-packaged goods (CPG) business, selling items like coffee and creamers in third-party retail outlets. CPG now does over $1 billion in sales annually. However, relatively little of this makes it back to Dunkin'. It generates revenue from licensing the brand instead of the sale directly, and it's recorded in the company's "other" revenue segment. This segment recorded just $31 million in revenue in the first half of 2020, and the segment includes additional items not even related to CPG.

The same thing goes for sales at Dunkin' and Baskin-Robbins. Because Dunkin' is completely franchised, there's a big difference between systemwide sales and revenue. Sales are what the franchisees record in the restaurant. What the franchisees pass on to Dunkin' is counted as corporate revenue. It's a relatively small slice of the pie. For example, in Q2 Dunkin' had $2.5 billion in systemwide sales, but it only recorded $287 million in total company revenue.

This structure is advantageous from a cash-flow perspective. Money regularly flows in, and ongoing costs are low. Therefore, Dunkin' has cash to reward shareholders via buybacks and dividends. And the dividend is a big part of a Dunkin' investment.

DNKN Chart

DNKN data by YCharts

Allow me to break down this busy chart. Over the last five years, Dunkin's dividend is up around 50% -- each year it raises the payment a little. When a dividend payment goes up, the dividend yield goes up. But when the stock price goes up, the yield goes down. These two factors constantly counteract each other, which is why dividend yield fluctuates.

The rising value of Dunkin' stock roughly matches the growth of dividend, keeping the dividend yield relatively stable at around 2% over that time. Right now, Dunkin's dividend yield looks historically low, but this accounts for the missed dividend payment in the first quarter. If you cut the company some slack for this one-time issue, the dividend yield actually looks perfectly normal right now.

Is it a buy?

Over the last three years, Dunkin' has only posted annual revenue growth of 2.2%, 3.6%, and 3.6%. I don't expect the growth rate to meaningfully accelerate, so I also don't expect Wall Street to take notice of this stock for growth reasons. I bet the stock will keep gaining at about the same rate as its dividend growth, which has been well under 10% for several years. I don't think that's enough to beat the market.

That said, I wouldn't call Dunkin' a risky stock. It's an iconic brand with staying power, and I presume it will continue to resonate with consumers. The company's structure does provide stability, which could make this a reliable dividend stock for income seekers. However, I believe investors can afford to be patient with Dunkin' stock. Occasionally, the dividend yield spikes to 2.5% and above (like earlier this year) which is historically a good entry point. 

Jon Quast has no position in any of the stocks mentioned. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.

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